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November 19, 2013

From Doom to Boom (and Back): Grantham Sees Stocks Soaring up to 30%, for Now

Breaking news: Stock market scold Jeremy Grantham expects the U.S. stock market to soar another 20% to 30% in the next year or “more likely” two — before the next mega-crash, at least.

The famed Grantham, Mayo, Van Otterloo & Co. hedge fund manager, who foresaw the credit crisis, is known for his relentlessly Malthusian forecasts about freaky weather, a shortage of food and excess of people, and a secular move away from economic growth.

While the GMO manager retains his pessimism about economic growth—he notes that Japan virtually alone among major economies bested the IMF’s growth forecast for 2013 by a tiny 0.7%, while most economies fell short of their modest projections — he credits monetary distortion with boosting stock markets.

Still, in his new quarterly letter to shareholders, Grantham sees the soaring stock market and underlying economy as out of whack:

“There have been few such occasions when such broad disappointment with economic growth still allowed the U.S. and most other major economies to make material upward moves in their stock markets. It is yet another testimonial to the global reach of the Fed’s stimulus of equities,” Grantham writes.

But that stimulus, of which he has been harshly critical, is succeeding at boosting stocks and has a way yet to go before the ultimate crash he foresees, since he finds the telltale signs of a traditional bubble largely absent.

Those signs would include ordinary investors pouring into mutual funds, which he says they are not yet doing consistently; CNBC talking heads making recommendations along the lines of Pumatech in 1999; and “wonderful and influential theories as to why the P/E structure should be much higher today as there were in 1989 or in the U.S. in 2000.”

Only an uptick in the IPO market suggests to Grantham that “we are probably in the slow build-up to something interesting…a badly overpriced market and bubble conditions.”

So Grantham’s “personal guess” is a further 20% to 30% stock market gain in the coming year or two before “we will have the third in the series of serious market busts since 1999,” a wreckage he describes as “the next utterly unnecessary financial and asset class failure.”

The hedge fund manager pins his “positive” forecast on deregulation as well as Fed stimulus, and makes clear that the run-up he anticipates in stocks is not based on valuation criteria.

“Investors should be aware that the U.S. market is already badly overpriced — indeed, we believe it is priced to deliver negative real returns over seven years,” he writes, adding that foreign markets are also overpriced, but less so.

Grantham therefore suggests that prudent investors will have to endure the pain of foregoing all the “fun at the top end of markets,” arguing that risk takers will “probably make some more money, but you may be bushwhacked and, if you are, your excuses will look thin.”

Grantham’s current forecast is very much in line with veteran bear John Hussman of the Hussman Funds, who one week ago cited a mathematical model suggesting a nearly vertical bull run before a coming crash that he considers unavoidable.

Most of Grantham’s lengthy letter has little to do with current market conditions but is rather a discourse, even diatribe, against efficient markets theory and criticism of the Nobel Committee’s award of its prestigious economics prize to Eugene Fama (though Grantham approves of co-recipient Robert Shiller).

The hedge fund manager also turns his withering attention on the once, current and future Federal Reserve chairmen, Alan Greenspan, Ben Bernanke and Janet Yellen.

Regretting that Larry Summers or others were not nominated, Grantham says monetary policy will be “same ole, same ole” under Yellen, whom he criticizes as someone “who has happily gone along with the failed Fed policy of hoping madly for a different outcome despite repeating exactly the same thing.”

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